Global insight

Is Cargolux China facing commercial ruin?

NO PERSON or business has ever made significant progress without taking a few calculated risks. Some argue the greater the risk, the greater the reward.

But this simple definition has no sympathy for scale, history or reputation and is leaving a string of influential air cargo industry professionals to wonder if the Cargolux China airline project is a miscalculated step too far, a commercial disaster waiting to happen, writes Thelma Etim.

According to a 2014 feasibility report by strategy consultants Roland Berger, the proposed dedicated Chinese cargo airline, in which its main shareholder, China’s state-owned Henan Civil Aviation Development and Investment (HNCA) owns the largest stake at 49 per cent, will rely heavily on a seven-year programme of Chinese state subsidies.

Long before the joint venture – in which Cargolux will sink at least US$77m – was officially announced on the Luxembourg all-cargo carrier’s website at the beginning of this year, questions were being raised in the air cargo marketplace about its commercial feasibility.

The biggest concerns hang over two vital issues: the choice of hub at Zhengzhou Xinzheng International Airport (CGO) in Henan Province, and the level of Chinese state subsidies that will be required in getting the airline off the ground in 2017 and keeping it in the air for another six or seven years.

Why? Well, at least 75 per cent of all of the cargo currently flown into China is consolidated at centres set up by freight forwarders some 1000 kilometres away from CGO at Shanghai Pudong International Airport (PVG) in the east. Shipments are then distributed from there using an established, proven network of improving road and interline air services.

The small cargo business currently transacted through CGO – which compares starkly with the consistent and substantial throughput (273,300 tonnes in January alone this year) in and out of Shanghai Pudong – means Cargolux China’s onward trucking options from the hub will be a liability to transit times and the addition of add-on costs will prove prohibitive. To be successful, the new airline will have to continue to seduce business away from Shanghai Pudong, and in order to do so it would have to undercut the current freight rates in both directions – currently down to 50-60 cents a kilo out of Europe, and worsening – “and what happens when you add the additional trucking costs to that figure?” argues a vexed senior air cargo forwarding customer.

“Is this a viable option?” he questions. “It is not the just the trucking [costs] within China that’s the issue, you also have the trucking costs at the front-end in Europe as well, from Cargolux’s Luxembourg hub in Europe, whereas carriers like Lufthansa can do air-to-air transhipments.”

That scenario would easily reduce the revenue earning potential on a round-trip Zhengzhou/Europe flight basis by at least $80,000 when compared with a Shanghai Pudong flight – and then the additional trucking costs come on top.

“Furthermore, would you put temperature-sensitive pharmaceuticals on a flight where it is going to be trucked twice?” he asks incredulously. When pharma shipments arrive at CGO they will need temperature-control treatment, which is significantly more expensive. “In my view, Cargolux China will have a colossal uphill battle,” the forwarder warns.

Other industry observers say shippers will not want to subject their luxury, branded commodities to long and unwieldy surface distribution networks. Drumming up business in China’s attractive and growing e-commerce market depends, like everywhere else, on time-critical, secure, fast performance.

One possible redeeming feature of the entire project is the proposed Chinese government’s agreed subsidy payments programme, which will artificially prop up the joint venture until 2023. “These funds will be needed to subsidise the entire operation until then,” underscores another air cargo veteran. “This means the project may work in the short-term – but I simply cannot see the venture having any credibility in the long-term,” he warns.

Building a business on subsidies is not seen as a wise move, as it could skew the profit-orientated culture of Cargolux and introduce a dangerous air of complacency. “It may just kill the spirit,” he adds.

The feasibility study document passed to aircargoeye.com clearly shows the joint venture will be hugely unprofitable before 2023 without the subsidies guaranteed by the Chinese government. The report reveals that these subsidies amount to a final total of US$810m, or 21 per cent of total revenues, and include a further $220m injection in capital and shareholder loans from 2018.

It is understood the Luxembourg shareholders of the project have been given the option to pull out of Cargolux China – if, for one reason or another, the subsidies cease before the cargo airline starts to generate real planned profits.

Another air cargo industry professional spoken to by aircargoeye.com describes the decision to create a business case for a new major air cargo gateway dependent on subsidies, as “weird”. The venture is a “politically-driven exercise and not based on normal supply-and-demand factors”, he asserts. Already, Cargolux is currently “dumping rates in both directions” in order to artificially increase the volumes at CGO, he alleges.

“In Europe [and the USA] everybody is complaining about potentially subsidised Middle East carriers skewing the market. Well, here we have a straightforward and blatant subsidy scheme and right in the face of European and US carriers,” argues another industry veteran. “How will this be perceived by the World Trade Organisation?” he questions.

The report shows the new carrier’s network will initially target legacy markets such as North America, including New York, Miami, Dallas, Los Angeles and Atlanta; and Asia, including Singapore, Chengdu, Taipei, Seoul, Bangkok, Jakarta and Kuala Lumpur, using an initial three B747 freighters. Thereafter, two more freighters will focus on growth markets described as having a “higher business risk”. These include Australia, Africa and South America, according to the study. This operations plan has its critics too. “How can a cargo airline set up an economically viable ‘hub-and-spoke’ model in the Far East in competition with the freighter/belly combination giants like Cathay Pacific and Singapore Airlines, and so forth – with relatively low belly distribution and feeder costs based on B777 and A330 passenger operations?” wonders another airfreight expert.

The project predicts the annual volume of cargo carried by the new airline will reach 192,000 tonnes in 2016/17, rising to 333,000 by 2022, whilst the average load factor is projected to be 67 per cent – similar to that of parent airline Cargolux. In the business plan, the five freighters, operated by a cockpit crew of 130 pilots, are expected to be operational for 15 hours a day on average.

Despite all these questions and doubts, the strategy consultants’ report goes on to describe the joint venture as “commercially interesting” for Cargolux and its shareholders – as it has the potential to expand the airline’s footprint in Asia whilst also creating economies of scale – and generating ‘platform benefits’ through fixed loan interests, GSA commissions, potential management contracts, and general load factor contributions to Cargolux’s existing EU business.

How Cargolux and its Chinese partners can remain confident of any of this is in itself open to question. Even after the world economy rebounded in 2010 airfreight has been forced to operate amidst prolonged uncertainty, with a number of new determining factors, including lacklustre global trade, modal shift and China’s own slowdown, amongst other downwards trends. And such a backdrop begs another big question: How are the ‘Big Three’ Chinese cargo carriers going to accept and live with this artificially created rival?

Despite a smattering of occasional upticks in air cargo fortunes, such as falling oil prices, the steady fallout has been marked by casualties and consolidation. Some freight airlines have gone out business, notably the ambitious Jade Cargo and Air Cargo Germany projects, whilst others have been forced to downsize operations, park aircraft, axe routes, outsource some key functions and wave goodbye to experienced personnel.

Mergers among big and small logistics players have become as commonplace as the constant pressure on their cargo yields, due mainly to the surging overcapacity of belly cargo forcing freight rates further down.

The frisson following online retailer and big air cargo customer Amazon’s announcement that it is to start its own operations by leasing 20 B767 freighters is the latest example of these seismic changes. Amazon’s move comes after months of speculation, rumour and innuendo in the freight and business media. Some observers say it is too early to predict whether that particular development is a game-changer, or not.

As for Cargolux China, the stakes remain frighteningly high. It must succeed in order to restore the status and reputation as well as safeguard the future of the 45-years-old Luxembourg carrier, once considered to be the world’s premier freight-only airline.

*Aircargoeye.com interviewed four senior air cargo professionals, all of whom were shown this article ahead of publication. They asked not to be named

*Cargolux was also sent a draft copy of this article ahead of publication and with a request for comments. Here is the Luxembourg airline’s response to aircargoeye.com below:

‘We appreciate your research into Cargolux China and the topic overall, however, by basing some of the statements on the Roland Berger study, although certainly well intended, you might misinform your readers as this study [is] certainly dated. The recent approval to invest into a new JV airline in Zhengzhou was based on updated market data and realistic assumptions by Cargolux.

‘Cargolux introduced airfreight services between Luxembourg and Zhengzhou in 2014. The success formula of a central hub with excellent trucking connections clearly shows in Europe, where Cargolux consistently outperformed the national heroes in Germany, Holland, France, UK and Italy, both in terms of growth and profitability!

‘The growth of Zhengzhou in terms of available infrastructure, dedication to cargo and tonnage in 2015 clearly shows the success of Zhengzhou as a new central hub in China. More and more, manufacturers move into the Chinese inland and trucking costs and transit times will soon outperform the capability of the congested legacy airports.

‘Henan province follows a long-term plan to attract investments in order to create jobs and be the primary link between China and Europe, which is in line with, and supported by the Chinese Government. Principles as applied by the Henan and Central governments are similar to those applied worldwide when it comes to creating incentive to support local growth. It is in typical Cargolux fashion to be the long-term visionary and jump in at an early stage when sceptics still limit their own future.

‘As a consequence, more and more shippers select Zhengzhou as the hub for Chinese spare parts distribution – major news can be expected during 2016.

‘In 2015, Cargolux transported 65,000 tons of airfreight to and from Zhengzhou and has increased its flights to 13 per week to/from Luxembourg, Milan, Chicago, Kuala Lumpur and Singapore. We will push hard to triple the volumes in the next 5 years and we are convinced that the attractiveness of Zhengzhou as a major airfreight hub in China and Asia will further grow with the addition of Cargolux China.

‘The market-leading global forwarders actively support the dual hub strategy and show a high interest in the additional services that will be provided by Cargolux China.

‘Finally, it is not a question of either Zhengzhou or Shanghai, those carriers that offer both destinations will win, carriers, such as Cargolux, that offer daily services to hubs such as Zhengzhou, Shanghai and Hong Kong and have direct services to cities such as Beijing and Xiamen, not only from Europe, but also from the USA and Intra-Asia.

‘A truly global network for the truly global customers is the key to success and Cargolux China plays an essential part in the strategy to be the global cargo carrier of choice.

‘We would be happy to give you the opportunity to talk to our CEO, Dirk Reich, and the Cargolux China project leader, Wieger Ketellapper, in person.Please do not hesitate to contact me for any further question.’